Arnold Company is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}\text { Cost of new machine }&\$100,000\
\text { Annual cost savings in cash expenses }&45,000\
\text { Terminal value } & 8,000 \
\text { Maintenance required in the 4th year } & 5,000 \
\text { Book value of the old machine } & 20,000
\end{array}$ The new machine would replace an old fully-amortized machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Arnold uses the straight-line method for amortization on all machines (ignore the half-year convention). Note: some amounts are rounded.
The present value of the total tax savings from the amortization tax shield is:
A) $21,630.00
B) $46,432.40
C) $50,470.00
D) $19,899.60

Question

Quizplus · Accepted Answer

The total tax savings from the amortization tax shield is calculated by taking the annual depreciation expense, multiplying it by the tax rate, and then finding the present value of these tax savings over the life of the asset. The annual depreciation expense for the new machine is the cost of the machine ($100,000) minus the terminal value ($8,000), divided by the life of the machine (5 years), which equals $18,400 per year. The annual tax savings is then $18,400 * 30% = $5,520. The present value of these annual tax savings over 5 years at a 12% discount rate is approximately $19,899.60.

Arnold Company Is Acquiring a New Machine with a Life